The U.S. can’t do much to solve the eurozone crisis, but stifling our own economic recovery could make it worse. (More)

The EU and Greece, Part III: What Won’t Help, and What Will (Non-Cynical Saturday)

This week Morning Feature has looked at the European Union, Greece, and the ongoing eurozone crisis. Thursday we discussed what the crisis is not: a small-scale model of the U.S. future. Yesterday we explored what the crisis is: a predictable and perhaps inevitable stage in the EU project. Today we conclude with what the U.S. should and should not do as the challenge evolves.

What Won’t Help: Austerity and the Kitchen Table Fallacy

German Chancellor Angela Merkel can’t understand why there is any controversy about fiscal austerity. “It’s just about not spending more than you collect. It’s astonishing that this simple fact leads to such debates.”

You might call it the Kitchen Table Fallacy, and it’s popular among conservatives in the U.S. as well. It says a government budget is like what you do when you work out family finances at the kitchen table. You can’t spend more than you take in. If the paychecks won’t cover everything, you have to tighten your belt. Chancellor Merkel calls that “this simple fact.”

There are many flaws with this fallacy. For example, Chancellor Merkel’s – and Republicans’ – response to a shortfall is one few families would consider: stop feeding the kids. In conservative terms, a family’s children are the ‘takers‘ who consume more than they produce. Newt Gingrich’s proposal to make poor kids work as school janitors to help support their families exposed that absurdity of the Kitchen Table Fallacy.

But the deeper problem with the Kitchen Table Fallacy is the implication that no family should ever buy more than they can afford with cash-on-hand. Families often borrow money for worthwhile reasons: to buy a home or a car, send children to college, or pay for repairs or medical bills. Paychecks are not always steady, and bills even less so. When the month’s bills exceed the month’s income, or they need to make long-term purchases, families borrow money. The payments on those loans join the monthly bills. When the income exceeds the month’s bills – from a better job, or a windfall like a tax refund or inheritance – responsible families pay off some of the loans.

Austerity and the Evidence

That idea of borrowing in a crunch and consolidating during good times is not just for families. Last September the International Monetary Fund released a report on fiscal austerity titled Painful Medicine. It wasn’t good news for Chancellor Merkel and her allies:

Recent IMF research provides an answer to this question. Evidence from data over the past 30 years shows that consolidation lowers incomes in the short term, with wage-earners taking more of a hit than others; it also raises unemployment, particularly long-term unemployment.

For the advanced economies, there is an unmistakable need to restore fiscal sustainability through credible consolidation plans. At the same time, we know that slamming on the brakes too quickly will hurt the recovery and worsen job prospects. Hence the potential longer-run benefits of fiscal consolidation must be balanced against the short- and medium-run adverse impacts on growth and jobs.

The evidence on austerity had been mixed, because previous studies treated any national budget deficit decrease as an example of austerity: “fiscal consolidation” in the IMF’s terminology. But not all of deficit decreases in those studies were caused by austerity policies. Some were revenue changes linked to other economic issues. Others were spending cuts to reduce inflation during a strong economy. When the authors filtered out those cases and looked only at tax increases or spending cuts for the express purpose of deficit reduction, the evidence for the “cut and grow” theory evaporated.

Simply, austerity causes an economy to contract. Like the family paying off bills, countries should cut deficits during good times … but not during a recession.

What Will Help: Save More Tomorrow

The Save More Tomorrow plan was developed by Nudge author Richard Thaler to help employees save more for their retirement. The idea is simple, and grounded in behavioral economics. The prospect of cutting the current budget to set aside money for retirement triggers our aversion to losing. We don’t miss what we don’t yet have – or at least we miss it less – so people find it easier to commit to shifting some part of a pay increase to retirement savings. Not every employee will sign up for the plan, but those who do tend to save a lot more than the rest of us.

This week the Congressional Budget Office proposed a similar idea to cope with the so-called “fiscal cliff,” the onset of U.S. austerity programs already agreed to in Congress. Unless Congress and President Obama reach other agreements, the Bush tax cuts will expire in January of next year, as will the payroll tax holiday and unemployment benefit extensions. The mandatory spending cuts of last August’s debt ceiling deal will also take effect in January. If they all happen, the CBO estimates the economy will slow to just 0.5% GDP growth in 2013. Add any other economic drag – like the eurozone debt crisis – and the U.S. will fall back into recession.

If those austerity policies are delayed, the CBO estimated GDP growth of over 4% in 2013. The obvious solution, say many economists, is what TPM‘s Brian Beutler called “stimulus now, fiscal restraint later.” It’s the government version of Save More Tomorrow … or the family paying down the bills during the good times.

President Obama should urge both European leaders and Congress to adopt a Save More Tomorrow policy. That policy will not guarantee a successful solution to the eurozone debt crisis. But with both the U.S. and the eurozone already facing the risk of recession in 2013, stubborn insistence on austerity – there or here – will almost guarantee a failure.

It’s time to stop what won’t work … and try what will.


Happy Saturday!